Thursday, February 20, 2014

Not everything we do, not even most of it, is done for profit, or with other practical aims in mind. John Kay:

In 1969 Robert Wilson, director of the National Accelerator Laboratory,
was testifying before the US Congress. He sought funding for a particle
accelerator (forerunner of the Large Hadron Collider at Cern where the Higgs boson was
discovered in 2012). Asked by Senator John Pastore how his project
would help defeat the Russians, he responded: “It only has to do with
the respect with which we regard one another . . . are we good painters,
good sculptors, great poets . . . new knowledge has nothing to do
directly with defending our country except to help make it worth
defending.”

Friday, February 14, 2014

I just read an essay by Mike Woodford from 2012, and I thought I might pass on a few interesting observations he made. He was responding to a criticism of rational expectations based DSGE modelling made by John Kay. What he says seems to make quite a bit of sense to me, especially about the need to model how people form expectations in a realistic way, going beyond the naive assumption of rational expectations, looking to empirical evidence instead (those comments come toward the end):

"There is... an important respect in which I do believe that much model-based economicanalysis
imposes a requirement of internal consistency that is unduly strong,
and that may result in unnecessary fragility of the conclusions reached;
and I suspect that this has a fair amount to do with the unease that
Kay expresses about modern economic analysis. It has been standard for
at least the past three decades to use models in which not only does the
model give a complete description of a hypothetical world, and not only
is this description one in which outcomes follow from rational behavior
on the part of the decision-makers in the model, but the
decision-makers in the model are assumed to understand the world in
exactly the way it is represented in the model.

This postulate of
“rational expectations,” as it is commonly though rather misleadingly
known, is the crucial theoretical assumption behind such doctrines as
“efficient markets” in asset pricing theory and “Ricardian equivalence”
in macroeconomics. It is often presented as if it were a simple
consequence of an aspiration to internal consistency in one’s model
and/or explanation of people’s choices in terms of individual
rationality, but in fact it is not a necessary implication of these
methodological commitments. It does not follow from the fact that one
believes in the validity of one’s own model and that one believes that
people can be assumed to make rational choices that they must be assumed
to make the choices that would be seen to be correct by someone who
(like the economist) believes in the validity of the predictions of that
model. Still less would it follow, if the economist herself accepts the necessity
of entertaining the possibility of a variety of possible models, that
the only models that she should consider are ones in each of which
everyone in the economy is assumed to understand the correctness of that
particular model, rather than entertaining beliefs that might (for
example) be consistent with one of the other models in the set that she
herself regards as possibly correct."

"...the mainstream
alternative developed in response to [the Lucas] critique --- according
to which aggregate consumer expenditure is modeled as the solution to
the Euler equation (a condition for intertemporal optimality) of a
representative household, under the hypothesis of rational expectations,
has difficulty matching the statistical properties of aggregate data
too closely. In order to avoid making strongly counter-factual
predictions, current-vintage empirical DSGE models commonly assume
preferences for the representative household that incorporate a high
degree of “habit persistence,” so that even when solved under the
assumption of intertemporal optimization under rational expectations,
consumer spending will not jump sharply in response to events that (at
least according to the model) should predictably change the future
path of household income. But the postulate of strong habit persistence
has not found much support from studies of the behavior of individual
households. An alternative explanation for the observation of persistent
departures from the predictions of the rational expectations
Euler-equation model under more standard preferences would be the
existence of persistent departures of actual household expectations from
those implied by the rational-expectations solution of the economists’
model."

"The macroeconomics of the future, I believe, will...
have to go beyond conventional late-twentieth-century methodology as
well, by making the formation and revision of expectations an object of
analysis in its own right... A prudent use of such an approach for
economic policy analysis would surely need to consider a variety of
possible assumptions about the forecasting approaches used by economic
agents, quite apart from the consideration that would be given to
uncertainty about the correct specification of the economic environment.

This absence of a single clear prediction about how people
should forecast is often considered to be a reason not to entertain such
hypotheses, and instead to prefer the hypothesis of rational
expectations, which aims to provide a unique prediction about
expectations in a given economic environment. But a more sensible
approach may be to accept that one should only expect one’s model of the
economy to deliver a range of plausible outcomes, rather than a unique
prediction...

Allowance for a set of possible outcomes under a given policy would lead to an approach to policy
design that would focus on the robustness of policy to possible
variations in the way that the consequences of the policy are understood
by people in the economy, rather than focusing solely on the optimality
of the policy if events unfold precisely as planned. It should lead,
for example, to a concern to design policies that make it more difficult
for asset bubbles to occur, or that should reduce the economic
distortions that result from them when they do occur, rather than
ignoring these issues on the ground that in a rational-expectations
equilibrium the bubbles should not occur. It should also lead to greater attention
to the communication policies of central banks and other governmental
actors, rather than assuming that official explanations of policy are
irrelevant given that economic agents can be expected to have rational
expectations --- and that these “rational” expectations depend only on
governmental actions, not upon speech."

"... What we should
outgrow... is the aspiration to build models that can not only be
regarded (at least provisionally) as correct representations of reality
for purposes of policy analysis, but that can be assumed to be self-evidently valid to everyone in the economy as well."

As with my last post, I'm trying to catch up here in linking to my recent Bloomberg pieces. This is my last one from two weeks ago. Given all the recent discussion of rising inequality, I wanted to point to a really fascinating paper from about 15 years ago that almost no one (in economics, at least) seems to know about. The paper looks at a very general model of how wealth flows around in an economy, and points to the existence of a surprising phase transition or tipping point in how wealth ends up being distributed. It shows that, beyond a certain threshold (see text below), the usual effect of wealth concentration (a small fraction of people owning a significant fraction of all wealth) becomes much worse: wealth "condenses" into the hands of just a few individuals (or, in the model, they might also be firms), not merely into the hands of a small fraction of the population.

Are we approaching such a point? I've mentioned some evidence in the article that we might be. But the important thing, I believe, is that we have good reason to expect that such a threshold really does exist. We are likely getting closer to it, although we may still have a ways to go.

****

We know that inequality is on the
rise around the world: The richest 1 percent command almost half
the planet’s household wealth, while the poorest half have less
than 1 percent. We know a lot less about why this is happening,
and where it might lead.

Some argue that technological advancement drives income
disproportionately to those with the right knowledge and skills.
Others point to the explosive growth in the financial sector.
Liberals worry that extreme inequality will tear society apart.
Conservatives argue that the wealth of the rich inspires others
to succeed.

What if we could shed all our political prejudices and take
a more scientific approach, setting up an experimental world
where we could test our thinking about what drives inequality?
Crazy as the idea might sound, it has actually been done. The
results are worth pondering.
Imagine a world like our own, only greatly simplified.
Everyone has equal talent and starts out with the same wealth.
Each person can gain or lose wealth by interacting and
exchanging goods and services with others, or by making
investments that earn uncertain returns over time.

More than a decade ago some scientists set up such a world,
in a computer, and used it to run simulations examining
fundamental aspects of wealth dynamics. They found several
surprising things.

First, inequality was unavoidable: A small fraction of
individuals (say 20 percent) always came to possess a large
fraction (say 80 percent) of the total wealth. This happened
because some individuals were luckier than others. By chance
alone, some peoples’ investments paid off many times in a row.
The more wealth they had, the more they could invest, making
bigger future gains even more likely.

For those who worry about the corrosive effects of wealth
inequality on social cohesion and democracy, the idea that it
follows almost inexorably from the most basic features of modern
economies might be unnerving. But there it is. A small fraction
owning most of everything is just as natural as having mountains
on a planet with plate tectonics.

Suppose we reach into this experimental world and, by
adjusting tax incentives or other means, boost the role of
financial investment relative to simple economic exchange. What
happens then? The distribution of wealth becomes more unequal:
The wealth share of the top 20 percent goes from, say, 80
percent to 90 percent.

If you keep boosting the role of finance and investment,
something surprising happens. Inequality doesn’t just keep
growing in a gradual and continuous way. Rather, the economy
crosses an abrupt tipping point. Suddenly, a few individuals end
up owning everything.

This would be a profoundly different world. It’s one thing
to have much of the wealth belonging to a small fraction of the
population -- 1 percent is still about 70 million people. It’s
entirely another if a small number of people -- say, five or
eight -- hold most of the wealth. With such a chasm between the
poor and rich, the idea that a person could go from one group to
the other in a lifetime, or even in a number of generations,
becomes absurd. The sheer numbers make the probability
vanishingly small.

Are we headed toward such a world? Well, data from
Bloomberg and the bank Credit Suisse suggest that the planet’s
138 richest people currently command more wealth than the
roughly 3.5 billion who make up the poorest half of the
population. Of course, nobody can say whether that means we’ve
reached a tipping point or are nearing one.

Experimental worlds are useful in that they exploit the
power of computation to examine the likely consequences of
complex interactions that would otherwise overwhelm our
analytical skills. We can get at least a little insight into
what might happen, what we ought to expect.

Our experimental world suggests that today’s vast wealth
inequality probably isn’t the result of any economic conspiracy,
or of vast differences in human skills. It’s more likely the
banal outcome of a fairly mechanical process -- one that, unless
we find some way to alter its course, could easily carry us into
a place where most of us would rather not be.

I've been remiss in not providing links to my last two Bloomberg pieces. Active web surfers may have run across them, but if not -- below is the full text of this essay from January. It looks at the question -- first raised here by Noah Smith -- of why, if DSGE models are so useful for understanding an economy, i.e. for gaining insights which can be had in no other way, no one on Wall St. actually seems to use them. Good question, I think:

****

In 1986, when the space shuttle Challenger exploded 73 seconds after
takeoff, investors immediately dumped the stock of manufacturer Morton
Thiokol Inc., which made the O-rings that were eventually blamed for the
disaster. With extraordinary wisdom, the global market had quickly
rendered a verdict on what happened and why.

Economists often
remind us that markets, by pooling information from diverse sources, do a
wonderful job of valuing companies, ideas and inventions. So what does
the market think about economic theory itself? The answer ought to be
rather disconcerting.

Blogger Noah Smith recently did an informal survey
to find out if financial firms actually use the “dynamic stochastic
general equilibrium” models that encapsulate the dominant thinking about
how the economy works. The result? Some do pay a little attention,
because they want to predict the actions of central banks that use the
models. In their investing, however, very few Wall Street firms find the
DSGE models useful.

I heard pretty much the same story in
recent meetings with 15 or so leaders of large London investment firms.
None thought that the DSGE models offered insight into the workings of
the economy.

This should come as no surprise to anyone who has
looked closely at the models. Can an economy of hundreds of millions of
individuals and tens of thousands of different firms be distilled into
just one household and one firm, which rationally optimize their
risk-adjusted discounted expected returns over an infinite future? There
is no empirical support for the idea. Indeed, research suggests that the models perform very poorly.

Economists
may object that the field has moved on, using more sophisticated models
that include more players with heterogeneous behaviors. This is a
feint. It isn’t true of the vast majority of research.

Why does
the profession want so desperately to hang on to the models? I see two
possibilities. Maybe they do capture some deep understanding about how
the economy works, an “if, then” relationship so hard to grasp that the
world’s financial firms with their smart people and vast resources
haven’t yet been able to figure out how to profit from it. I suppose
that is conceivable.

More likely, economists find the models
useful not in explaining reality, but in telling nice stories that fit
with established traditions and fulfill the crucial goal of getting
their work published in leading academic journals. With mathematical
rigor, the models ensure that the stories follow certain cherished
rules. Individual behavior, for example, must be the result of
optimizing calculation, and all events must eventually converge toward a
benign equilibrium in which all markets clear.
A creative
economist colleague of mine told me that his papers have often been
rejected from leading journals not for being implausible or for
conflicting with the data, but with a simple comment: “This is not an
equilibrium model.”

Knowledge really is power. I know of at least one financial firm in London
that has a team of meteorologists running a bank of supercomputers to
gain a small edge over others in identifying emerging weather patterns.
Their models help them make good profits in the commodities markets. If
economists’ DSGE models offered any insight into how economies work,
they would be used in the same way. That they are not speaks volumes.

Markets,
of course, aren’t always wise. They do make mistakes. Maybe we’ll find
out a few years from now that the macroeconomists really do know better
than all the smart people with “skin in the game.” I wouldn’t bet on it.

Wednesday, February 12, 2014

This is a bit old, but I just happened onto this interesting post at Econospeak contributed by Peter Dorman. It pulls no punches, and suggests that the stamp above might be appropriately applied to most of the highly "insightful" and "sophisticated" papers of modern micro-founded macroeconomics:

... Microfoundations for macroeconomics are fine in principle—not
indispensable, but useful. The problem is that what passes for
microfoundations in the universe of orthodox macro is crap.

There. I said it. I used the “c” word. But not the “s” word.

It’s nothing more than robotic imitation of teaching exercises to
improve math skills, without any consideration for such mundane matters
as empirical verisimilitude. I will mention three crushing faults, each
sufficient by itself to blow a wide hole in a supposedly useful model.

1. Utility theory. Andrew Gelman
calls this “folk psychology”; that may be generous. It is rife with
anomalies (see “behavioral economics”), and, most important, it is
oblivious to the last several decades of work in psychology,
evolutionary biology, neuropsychology, organization theory—all the
disciplines where people study behavior in a scientific way.

2. Mono-equilibrium assumptions. There are no interaction effects to
generate multiple equilibria in the microfoundations macro theorists
use. Every individual, firm and product is an isolated atom, floating
uninterrupted through space until it bumps into another such atom in the
marketplace. Social psychology, ecology, nonconvex production and
consumption spaces? Forget about it. In evolutionary biology, by
contrast, fitness surfaces are assumed nonconvex from the get-go; it’s
central to the discipline. Failure to recognize the interactive
character of economic life leads economists to ask fundamentally wrong
questions, like “what’s the equilibrium?” and “what’s the optimum?” If
this isn’t obvious to you already, you can get a longer version of the
argument here.
(Note for those who are wondering: no, nonconvexity stemming from
interaction effects has nothing to do with market failure. The
existence of externalities is neither necessary nor sufficient for
these effects. See for yourself.)

3. Path dependence. Microfoundations means general equilibrium theory,
but the flavor it uses is from the mid-1950s. The
Sonnenschein-Debreu-Mantel demonstration (update to the 1970s) that
initial conditions and out-of-equilibrium trades alter the equilibrium
itself (they assume away problem #2) has turned GET upside down.

Notice that I haven’t mentioned the standard heterodox criticisms of
representative agents and ergodicity. You can add those if you want.

Now here’s the clincher. As Krugman points out, faced with the choice
between addressing the evidence or maintaining consistency with their
microfounded models, macroeconomists as a herd have gone for the second.
This is because they believe that the micro theory they use is really,
really, really true, and that no model that cannot be yoked to it can
be considered scientific. And if we actually knew with certainty that
mid-50s general equilibrium theory with optimizing agents and no
interactions outside the market was the only acceptable framework for
thinking coherently about economics, they’d be right. But they’re not.

I posted yesterday on the new book by Kartik Athreya, Big ideas in Macroeconomics: a non-technical view. There's a blurb on the back by Herb Gintis, who I think is a very smart guy and worth listening to. I noticed he also has written a review on Amazon, which is titled: At Last! A Serious Presentation and Defense of Modern Macroeconomic Theory. That sounds really positive, doesn't it?I thought, wow, Gintis thinks the theory is in great shape? I'm shocked, and I have to think hard about what he says. The review starts out saying nice things about the book. But then look at the parts I've highlighted below:

It is easy to find excellent, accurate, accessible, and entertaining
books that present the current theories and ideas in many fields,
including law, physics, and biology. It is virtually impossible to find
such books in economics. Sadly, when someone writes a book about
economics, it almost always is an attempt to convince the reader that
some politically motivated partial truth is the whole truth.

There
are some books that present basic economic theory in an unbiased
manner, and I review the ones I have found in an entry on my web site
(http://people.umass.edu/gintis). Click on You Must Read This! and look
for "Books on Economics for Serious Beginners: Very Introductory
Readings."

But for the sort of advanced macroeconomic that guided
policy makers and central bankers leading up to the financial meltdown
of 2008, there has been virtually no serious accessible exposition
without a political bone to pick. I love this book because it treats the
reader as intelligent and discerning, presents the theory ably and in
great detail, but avoids the mathematical detail that makes the material
quite impenetrable to all but the expert who spends the bulk of his
time devoted to the subject.

The reader who even cursorily
inspects this book might consider me a biased observer because I
contributed a blurb to the book jacket and the author graciously thanks
me for my support in the introductory pages. The fact is that I consider
this an exemplary exposition of modern macroeconomics, and I think his
defense of the theory is as good as one can find anywhere, the theory is
in fact so weak that nothing can save it. People continue doing it not
because it is good theory, but because it is the only game in town. I
believe a complete revolution in macroeconomic theory is in the process
of being born, although it will take some years to take over as the
mainstream theory.

Change in macroeconomic theory can be
extremely rapid. Keynesianism displaced classical macroeconomics in
just a few years after the end of WWII, and the reigning "rational
expectations" macro displaced Keynesianism in just a few breathtaking
years. This is a credit to economics as a discipline--given new evidence
and given new economic conditions, young Ph.D. economists are quite
willing to throw over the past, and in the best graduate schools, hiring
of new faculty is based on how productive they are as researchers, not
whether or not they agree with the reigning orthodoxy.

Macroeconomics
has always been deeply political. After WWII in Europe and the US, the
growth in organized labor led to cost-push inflation (higher wages
--> higher prices) and unemployment caused by wages above the
market-clearing level. Keynesianism blamed the unemployment on the
market system itself and suggested deficit spending as the way to
restore full employment and accommodating higher prices by increasing
the money supply. Of course, this is a stupid theory because it leads to
chronic deficit spending and chronic inflation. With the decline in the
power of organized labor (caused mainly by increased international
competition eliminating domestic monopolies in internationally traded
goods such as steel, mining, and automobiles), a resurgent right-wing
macroeconomics, called rational expectations theory, displaced Keynesian
macro by recognizing the fatal flaws in its reasoning, which
contradicted economic rationality. Keynesianism remains today in an
attenuated form that recognizes coordination failures and price inertia,
but is mainly a liberal profession of faith.

The only virtue of
rational expectations macro (RA macro), which Athreya explains so nicely
in this book, is that it killed Keynesian macro. The theory itself is
nothing but smoke and mirrors. It purports to be solidly based on
widely-accepted microeconomic principles that accurately describe the
market economy (the "rational" in rational expectations), but this is
simply false. The market economy is in fact a complex dynamic system
whose behavior can be simulated, much as the weather is simulated by
supercomputers, but cannot be captured in a few recursive equations, as
the RA macro supporters claim. Instead of a large number of economic
actors, RA macro assumes there is one "representative agent," and
instead of large numbers of firms and industries, RA macro assumes there
is one "production function." The only source of volatility in such a
world is technology shocks and the vagaries of "expectations" (which of
course cannot be measured, because they don't really exist). All we end
up with is smoke and mirrors, plus lots of abstruse equations.

Among
the more bizarre modeling choices of RA macro is to assume that all
markets clear instantaneously. This of course assumes away the
coordination failures that really underlie macroeconomic fluctuations.
Especially exotic is the assumption that there is always full
employment! "Unemployed" workers are simply people who temporarily
prefer not to work (they prefer "leisure," in the parlance of macro
theory). In fact what happens in a recession is that millions of jobs
disappear. The displaced workers prefer their old or equivalent jobs at
their accustomed wages, but these are gone. Of course, many could find
work at a lower wage, but that is not always the rational thing to do
because the worker may get locked into the lower wage occupational
level.

This absurd sort of macro modeling would be okay if the
resulting models predicted well, but they do not. RA macro long ago gave
up econometric testing their equations in favor of "calibrating" them,
which means just get the best fit you can, however poor. An poor they
are.

Of course, prediction is not everything. Engineers cannot
predict when a car will go over a bump, but they can model the effects
of such a shock on the car and proposed mechanisms (shock absorbers)
that allow the system (the car) to survive the shock with minimal
damage. The same is true, to a much more limited extent in
macroeconomics, where "automatic stabilizers" can lessen the effects of
shocks to the economy.

The real problem with RA macro (and
similarly of Keynesian macro) is the theory cannot deal with finance at
all, and financial markets lie at the heart of contemporary economic
instability. The Walrasian micro model on which RA macro is built simply
has no place for money or finance. Graduate students in economics do not
even study finance---that is left to the business schools.

Of
course, all of that is now changing. Economists around the world are
revamping their theories and developing the empirical data on finance so
that a more useful theory is likely to be forthcoming. It is a very
exciting time for macroeconomics. Athreya's defense of the current
theory is quite brilliant and I urge the reader to learn from him.
However, we all know the story of the silk purse and the sow's ear.

In short, nice attempt on an impossible task: giving a coherent defense of modern rational expectations macroeconomics.

Tuesday, February 11, 2014

Kartik Athreya is an economist at the Federal Reserve Bank of Richmond. He is a true believer in the modern methods of macroeconomics, and has written a new book entitled Big ideas in Macroeconomics: a non-technical view. I've just had a partial read of the first 50 pages or so on google books.

Athreya is really irritated at all the criticism that macroeconomists have had to endure since the onset of the financial crisis. He famously expressed his irritation a few year ago, demanding that bloggers and non-economists in general shut up and leave discussion of economics to himself and other experts in the field. It seems that the purpose of the new book is to correct all the confusion and explain to everyone why modern macro is so wonderful and right and beyond criticism. I don't think it is going to succeed. Anyone who reads his section on the Walrasian Clearinghouse -- an imaginary mechanism to explain how an economy reaches Walrasian equilibrium -- will pretty quickly come to the conclusion that Athreya's beloved picture of how an economy works is mostly mathematical fantasy.

But actually, I think the book may in this way provide a great service. Anyone who reads it carefully will be able to see for themselves just how fragile and artificial the modern rational expectations approach to macroeconomics really is. I'm going to order the book because, from what I have seen, there will be much to learn, although possibly not about how a real economy works. Readers will experience a close encounter with the reality-defying attitude and arrogance of mainstream macroeconomics. Reading from one who holds it in such high esteem, the reader can also trust that he or she is not being deceived by some ignorant blogger who is setting up straw man arguments (a common response from wounded macroeconomists).

David Glasner has read the book and offers an informative review. One section deserves highlighting, regarding Athreya's tendency to dismiss whole realms of real economic phenomena as irrelevant simply because they don't fit into his preferred modelling methodology:

As Athreya acknowledges in chapter 5, an
important issue separating certain older macroeconomic traditions (both
Keynesian and Austrian among others) is the idea that macroeconomic
dysfunction is a manifestation of coordination failure. It is a property
– a remarkable property – of Walrasian general equilibrium that it
achieves perfect (i.e., Pareto-optimal) coordination of disparate,
self-interested, competitive individual agents, fully reconciling their
plans in a way that might have been achieved by an omniscient and
benevolent central planner. Walrasian general equilibrium fully solves
the coordination problem. Insofar as important results of modern
macroeconomics depend on the assumption that a real-life economy can be
realistically characterized as a Walrasian equilibrium, modern
macroeconomics is assuming that coordination failures are irrelevant to
macroeconomics. It is only after coordination failures have been
excluded from the purview of macroeconomics that it became legitimate
(for the sake of mathematical tractability) to deploy
representative-agent models in macroeconomics, a coordination failure
being tantamount, in the context of a representative agent model, to a
form of irrationality on the part of the representative agent. Athreya
characterizes choices about the level of aggregation as a trade-off
between realism and tractability, but it seems to me that, rather than
making a trade-off between realism and tractability, modern
macroeconomics has simply made an a priori decision that coordination
problems are not a relevant macroeconomic concern.

A similar argument applies to Athreya’s
defense of rational expectations and the use of equilibrium in modern
macroeconomic models. I would not deny that there are good reasons to
adopt rational expectations and full equilibrium in some modeling
situations, depending on the problem that theorist is trying to address.
The question is whether it can be appropriate to deviate from the
assumption of a full rational-expectations equilibrium for the purposes
of modeling fluctuations over the course of a business cycle, especially
a deep cyclical downturn. In particular, the idea of a Hicksian
temporary equilibrium in which agents hold divergent expectations about
future prices, but markets clear period by period given those divergent
expectations, seems to offer (as in, e.g., Thompson’s “Reformulation of Macroeconomic Theory“) more realism and richer empirical content than modern macromodels of rational expectations.

Athreya offers the following explanation and defense of rational expectations:

[Rational expectations] purports to explain
the expectations people actually have about the relevant items in their
own futures. It does so by asking that their expectations lead to
economy-wide outcomes that do not contradict their views. By imposing
the requirement that expectations not be systematically contradicted by
outcomes, economists keep an unobservable object from becoming a source
of “free parameters” through which we can cheaply claim to have
“explained” some phenomenon. In other words, in rational-expectations
models, expectations are part of what is solved for, and so they are not
left to the discretion of the modeler to impose willy-nilly. In so
doing, the assumption of rational expectations protects the public from
economists.

This defense of rational expectations
plainly belies the methodological arrogance of modern macroeconomics. I
am all in favor of solving a model for equilibrium expectations, but
solving for equilibrium expectations is certainly not the same as
insisting that the only interesting or relevant result of a model is the
one generated by the assumption of full equilibrium under rational
expectations. (Again see Thompson’s “Reformulation of Macroeconomic
Theory” as well as the classic paper by Foley and Sidrauski, and this post
by Rajiv Sethi on his blog.) It may be relevant and useful to look at a
model and examine its properties in a state in which agents hold
inconsistent expectations about future prices; the temporary equilibrium
existing at a point in time does not correspond to a steady state. Why
is such an equilibrium uninteresting and uninformative about what
happens in a business cycle? But evidently modern macroeconomists such
as Athreya consider it their duty to ban such models from polite
discourse — certainly from the leading economics journals — lest the
public be tainted by economists who might otherwise dare to abuse their
models by making illicit assumptions about expectations formation and
equilibrium concepts.

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